Although all eyes have been on Southeast Asia since October, it's not the only game around. A broader look shows that the financial crisis in that part of the world is to global deflation what the 1973 oil embargo was to inflation: it focuses and augments the many forces already at work. For the last two decades, governments, corporations, and new technologies have promoted actions that, given certain triggers, will push prices down.
In his comprehensive new book, Deflation, A. Gary Shilling points out the deflationary forces at work in the world, analyzes the impact of the Asian financial crisis, and predicts the kind of deflation that will likely result.
Governments, for example, have done their part by reducing spending and shrinking deficits. With the Cold War over, US defense spending keeps falling dropping from 7.4% of GDP in the third quarter of 1986 to 4% in the first quarter of 1998. Continental governments endure double- digit unemployment rates to move toward the Maastricht target, deficits no more than 3% of GDP. Deregulation among utilities and services is also lowering prices. In the US, Citizens for a Sound Economy, a Republican think-tank, predicts that deregulation of the electricity market would lead to a drop of "at least 43%" in consumers' electricity bills.
Meanwhile, central banks are still fighting the last war, inflation, with higher interest rates. Corporations are adding to deflation momentum with the restructuring that started in the US and UK in the 1980s and has spread to other English-speaking lands. Global outsourcing now provides not only less expensive goods but also cheaper services, including credit card processing and computer programming. Computer and information technology has deflation written all over it. Hardware and software are notoriously prone to price cuts, and users buy the stuff to reduce their own costs.
Outside the US, newly industrialized countries as well as countries recently freed from Communism are becoming major players in the export market. The result is a global glut of products and no one to buy them. With Southeast Asia's financial woes, its consumers are not much of a market, and the US the world's happy dumping ground can only buy so much. Faced with increasing global glut, countries wanting to use exports to improve their economies are more likely than ever to devalue their currencies. No doubt a strengthening dollar is deflationary to the US, and no doubt it is currently welcomed by Washington. But what happens as global glut and weak US exports meet rising labor costs, spurred by the drum-tight US labor market, head on? What happens if a profit squeeze kills overpriced US stocks, and individual investors who rely on their equity portfolios as their savings accounts suffer big losses?
Consumers retrench. Then they watch prices fall, and in a classic move that makes deflation a self-feeding phenomenon, they wait for prices to go even lower before spending a dime.
If, by some slim chance, the Asian crisis proves to be a nonevent for the US, the Federal Reserve will no doubt tighten credit and probably precipitate a recession, preceded, as usual, by a bear market in US stocks. The net effect on consumer behavior would be the same, and as with the case of an Asian-initiated bear market, the end result would be deflation.
When we in the US think of deflation, we think of the 1930s. Its images of soup lines and shanty towns are so vivid that any other idea of deflation pales by comparison. But there was deflation after the Civil War without the financial collapse of the '30s. The deflation Dr. Shilling forecasts coming soon is more likely to be characterized by the oversupply of the late 19th century than the unemployment of the Depression.
The final chapters of Deflation explain how deflation will affect you. Should you keep your stock investments or switch to bonds? Will your company need to be restructured again? What should you do about inventories? Have you personally been saving enough? Dr. Shilling gives you 13 investment strategies, 18 business strategies, and five personal strategies that will work in the deflationary years ahead.
Be prepared. In future years we may conclude that in the summer of 1997, Asia was the trigger for global deflation.
Dr. A. Gary Shilling is president of A. Gary Shilling & Company, Inc., economic consultants and investment advisors, managing individual and institutional accounts. The firm also publishes INSIGHT, a monthly report of economic forecasts and investment strategy, and Dr. Shilling advises Thematic Investment Partners and Thematic Futures Fund, investment partnerships oriented toward economic, financial, and political themes.
A regular columnist for Forbes magazine, he has been twice ranked as Wall Street's top economist by Institutional Investor magazine's poll of financial institutions , and Futures magazine ranked him the country's number one Commodity Trading Advisor in 1993. Although Dr. Shilling does not yet manage any mutual funds, CNBC anchor Bill Griffeth was so impressed with his investment approach that he profiled him along with 19 well-known mutual fund managers in his 1995 book, The Mutual Fund Masters.
Dr. Shilling is well known for his forecasting record. In the spring of 1969 he was among the few who correctly saw that a recession would start late in the year. In 1973 he stood almost alone in forecasting that the world was entering a massive inventory building spree to be followed by the first major worldwide recession since the 1930s. In the late 1970s, when most thought that raging inflation would last forever, he was the first to predict that the changing political mood of the country would lead to an end of severe inflation, as well as to potentially serious financial and economic readjustment problems.
His first book, co-authored with Kiril Sokoloff, was published by McGraw-Hill in the spring of 1983 and entitled Is Inflation Ending? Are You Ready? In it, the authors answered the first question in the title with a resounding yes. But to the second they said, no, you're not ready. Your investments, your business, and your personal life are geared to inflation lasting forever, not disinflation. Your portfolio is crammed full of tangible assets like coins, antiques, and real estate the great inflation hedges of the 1965-80 era of accelerating prices, but assets that would suffer as inflation rates fell. At the same time, you own far too few financial assets, especially stocks and bonds disastrous investments in periods of high inflation, but great winners in disinflation.
Inflation, however, was so deeply ingrained in everyone's thinking that the initial signs of its exit were ignored. The book's reviewers basically dismissed the authors' ideas. But by the mid 1980s, their forecast of inflation's demise began to look credible. In a delayed victory of sorts, David Warsh of the Boston Globe essentially reviewed the book in that newspaper's March 13, 1986, edition, and Bruce Ramsey did the same for the April 2, 1986, issue of the Seattle Post Intelligence in an article entitled "A preposterous economic prediction that came true."
By then inflation rates not only had fallen considerably, but stocks and bonds were thriving while tangibles were in trouble. Dr. Shilling was convinced that more of the same lay ahead because the world of shortages seemed to be over and a world of surpluses was in prospect. His second book, The World Has Definitely Changed New Economic Forces and Their Implications for the Next Decade (Lakeview Press, 1986) , spelled out this thesis.
The 1987 stock market crash raised the possibility that deflation and not just low inflation might be in the cards, and his third book, After the Crash, Recession or Depression? (Lakeview Economic Services, 1988), explored this idea. Despite the title, he wasn't specifically forecasting deflation, but came closer to doing so when he, assisted by Anne D. Willard, created "The Deflation Game" in 1989. It's a Monopoly-like board game that is biased toward winning with financial asset holdings and losing with tangibles.
Dr. Shilling is widely recognized as the world's oldest living disinflationist, since his forecast of low inflation is over 20 years old and his suggestion of possible deflation has been around for about a decade.
He received his A.B. degree in physics, magna cum laude, from Amherst College, where he was also elected to Phi Beta Kappa and Sigma Xi. He earned his M.A. and Ph.D. in economics at Stanford University. Before establishing his own firm in 1978, Dr. Shilling was Senior Vice President and Chief Economist of White, Weld & Co., Inc. Earlier he set up the Economics Department at Merrill Lynch, Pierce, Fenner & Smith at age 29 and served as the firm's first chief economist. Prior to Merrill Lynch, he was with Standard Oil Co. (N.J.) where he was in charge of U.S. and Canadian economic analysis and forecasting.
In addition to writing for Forbes, Dr. Shilling is a columnist for Standard & Poor's CreditWeek and a member of The Nihon Keizai Shimbun (Japan Economic Journal) Board of Economists. He appears frequently on business radio and television shows.
Dr. Shilling is on the Board of Directors of National Life of Vermont, the Heartland Group of mutual funds, the American Productivity and Quality Center, Palm Harbor Homes, the Episcopal Evangelism Foundation of which he is Chairman; an Advisory Director of Austin Trust Company; a Trustee and the Treasurer of the General Theological Seminary (Episcopal); and a Chairman of the New Jersey State Revenue Forecasting Advisory Commission. He is also an avid beekeeper.
